Ukraine to adopt financial bill as regulators seek agreement

LONDON (ICIS)–Ukraine is preparing to pass a critical financial law in a bid to set up a modern capital market. The proposed draft law has raised questions over the remit of energy and financial regulators.

The 2284 bill which has passed its second reading and could be approved in parliament by the end of the month includes provisions that align with those of the EU’s Markets and Financial Instruments Directive II (MIFID II).

These reforms include the introduction of clearing services, payment netting and close-out netting. Payment netting refers to the grouping of multiple cash flows into a single netted account, allowing counterparties to offset positive and negative values and reducing cash flow risk.

Close-out netting is a key provision involving the termination of obligations under a contract with a defaulting party.

The law was essential to the establishment and consolidation of electricity and gas markets as well as attracting potential new traders looking to become active in Ukraine, Timur Khromaev, chairman of the national securities and stock market commission (NSSMC) told ICIS. Many traders stayed out of Ukraine due to market risks and the absence of statutory enabled risk mitigation, Khromaev said. The existing financial legislation dated back to 1991 and required urgent updating and alignment with EU practices, he added.

Khromaev said there was a general misunderstanding in the market regarding the importance of financial instruments and their role in mitigating risk.

The view was echoed by some foreign sources active in the country who noted that there was a pressing need to introduce rules with regards to clearing services, a clear definition of title transfers and the establishment of transparent practices for price discovery.

“There are several clearing houses such as [Hungary-based] Keler or ECC [European Commodity Clearing] which are interested in entering Ukraine, but there is a need for clear rules for them to enter the market,” an EU policy maker said. Otherwise, traders in Ukraine will need to perpetuate pre-payment which in turn hinders the emergence of any liquidity in wholesale markets.

DEBATE

However, the draft law had sparked debate because in its initial version, the bill was thought to have extended the remit of the financial regulator to the commodities market.

The energy watchdog retained significant authority over the electricity and gas markets, which meant that the regulator was keen to ensure that physical markets remained outside the jurisdiction of NSSMC, Olena Antonova, commissioner at the energy regulator NERC said.

The spot market would be under the supervision of NSSMC which meant that the financial regulator would be allowed to license the market and be granted oversight, she added.

Following discussions NERC and NSSMC agreed on a REMIT carve-Out. The REMIT carve-out means that forward electricity and natural gas products that are physically settled and which are traded on an organised trading facility (OTF) would not qualify as MIFID II financial instruments and would therefore be outside its scope of application.

Under this agreement, the physical electricity and gas markets as well as balancing markets would remain under the supervision of NERC.

“The way 2284 was written meant that it could lead to double regulation. We did not want markets to fail because of overregulation,” Antonova said.

The NERC had worked with NSSMC and members of parliament to reach a compromise and argued that parties had now succeeded in coordinating 95% of the work, she said.

“NERC fully supports the NSSMC efforts to develop financial instruments and the provision of clearing services would positively impact trading and competition,” she said.

A second EU policy maker questioned the need to introduce a sophisticated capital markets law at a time when Ukraine’s physical electricity and gas markets were yet to develop.

“We are buying a Porsche before building the road,” the source said.

“Such a financial law is very important, but in its current form it may be going too far. Market participants do not understand the market structure,” he said.

However, a letter published by the European Federation of Energy Traders (EFET) reiterated the need for the introduction of the REMIT carve-out to ensure that physical spot trading was not subject to financial regulations.

“We have witnessed that [European] market participants have a strong preference to trade bilaterally, over the counter, or on broker platforms,” the EFET letter to Ukrainian policy-makers said.

“We underline the need to provide for a REMIT carve out in the intended [Ukrainian] legislation as utilities do not wish to be subject to financial regulation,” it added.

EFET stated that the capital reform bill needed to be strongly supported, provided that these basic conditions are met.